lunes, 16 de junio de 2014

lunes, junio 16, 2014

US companies keep buying and keep borrowing

Andrew Smithers

Jun 12 08:45




I wrote in an earlier blog that I would become more cautious about US equities if profit margins came down. We have just had the figures for the first quarter of 2014 and profit margins have narrowed. I should therefore keep readers up to date and explain why I do not think the latest data are signalling the top of the market.

As I pointed out in “US corporate debt and cash flow”, US companies have been the key buyers of the stock market and the rate at which they have been buying shares is unsustainable, because debt cannot continue to grow at the pace needed to finance the purchases. The difficulty with things that cannot go on is deciding when they will stop and I will try to explain why I think this point has not yet arrived, despite the uncertainty that anyone must have about such things.



The new data, published on May 29, show that profit margins fell in Q1 2014 (see chart one). Nonetheless, I think it would be premature to treat this as a clear bear signal, because it was a quarter in which corporate output fell, even when seasonally adjusted, and the severe weather can reasonably be held to blame for the decline.



The decline in profit margins means that corporate cash flow has fallen, but the message on profits is more complicated. National income and product accounts profits fell on one measure and rose on another and, importantly, the measure on which they rose is nearer than the other to the way that companies report their profits to shareholders.



The main difference between the two measures lies in the capital consumption, or CC, adjustment. The national accountants include this in their preferred profit figure. It aims to show the rate of capital consumption (aka depreciation) that allows for the impact of inflation. But companies report their profits at book values, so the capital consumption without the CC adjustment is a better guide to the profits that US companies show in their accounts.




Corporate cash flow fell, whichever way profits are defined. New data on US financial accounts, the “Z.1published earlier this month, show that this did not affect corporate share buying. Buy-backs continued unabated at an annual rate of $400bn (see chart two), which is 2.5 per cent of gross domestic product

Despite slightly lower investment and a slight fall in dividend payments, non-financial corporate debt grew even faster than before and has expanded by 9.2 per cent over the past 12 months, with the result that US non-financial companies’ leverage is now at an all-time high relative to output (see chart three).




There are therefore three reasons for not worrying too much about the fall in profit margins. First, this may well prove to be a one-off event resulting from exceptional bad weather. Second, profits in the way companies look at them rose, even as measured in the national accounts. Third, there was no diminution in company buying.

There are still, of course, some good reasons for caution. The new Z.1 data allow the value of the US stock market to be updated and, as shown on my website, as at June 6 2014 with the S&P 500 index at 1,949 points the overvaluation shown by q was 88 per cent for non-financials and 87 per cent as shown by the cyclically adjusted price/earnings ratio, or Cape, for quoted shares.

Another mild worry is shown by the ratio of cash to debt. As chart four shows, this has seemed to be a leading indicator of buy-backs but these have so far held up, despite the decline in the cash/debt ratio.




There is, however, a large difference between the conditions when the cash ratio was falling from 2006 to 2009 and the more recent decline. This is the massive amount of liquidity that the Federal Reserve is continuing to inject into the US economy (see chart five).




The Fed is tapering, but that only slows the growth of liquidity, it does not reverse it and the more liquidity there is, the less pressure there is on other, non-corporate investors to sell.

The next lot of data on profit margins, corporate balance sheets and equity buying are due in September. There seems to me to be a good chance that profit margins will have recovered or at least stopped falling, and that companies will have continued to buy shares and raised their leverage to even greater heights.

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